Wednesday, November 14, 2007

• The write-downs announced by RY are extremely benign and pale by comparison to writedowns taken by a number of global players. The very modest write-downs reflect the Canadian banks high asset quality and extremely low exposure to the high risk areas being impacted by the credit and liquidity crunch. We believe the market was discounting substantially higher write-downs for RY.

VISA Gains - RY $325M - Inline

• RY announced that it will book a $325 million gain ($270 million after-tax or $0.21 per share) from the completion of VISA's restructuring, in line with expectations.

• RY announcements follow similar announcements from CM and TD with VISA gains of $456 million gain ($381 million after-tax and $1.14 per share) and $163 million gain ($135 million after-tax and $0.19 per share), respectively.

RY - Benign CDO Write-Down of $0.13 Per Share

• RY announced a relatively benign write-down of $360 million pre-tax ($160 million after tax and compensation adjustments or $0.13 per share) on its CDOs and RMBSs. This pre-release implies to us that there will be no other major write-downs. We believe the market was discounting a much higher write-down.

RY - Additional $120M Charge Relating to Credit Card Liabilities

• RY also announced a $120 million pre-tax ($80 million after-tax or $0.06 per share) charge relating to an increase in credit card customer reward program liability.

RY - Net Impact of Unusual Items Minimal

• The RY VISA gain of $0.21 per share is offset by $0.13 per share CDO/RMBS write-down and $0.06 per share charge for credit card reward program liability for a net gain of $0.02 per share.

• We consider the VISA gain as one-time and other charges as operating.

Write-Downs Expected From BMO and NA

• We continue to expect NA to announce a $500 million (or $2.00 per share) write-down on its $1.85 billion exposure to non-bank ABCP.

• There is a lot of uncertainty surrounding BMO in terms of the bank's potential write-downs from non-bank ABCP liquidity facilities and perhaps recent holdings in non-bank ABCP, as well as its Structured Investment Vehicles (SIVs). The potential magnitude of the writedown is difficult to ascertain but could be as high as $500 million.

Recommendation

• We are trimming our Q4/07 earnings estimates on RY to $0.85 per share from $1.00 per share to reflect the announcements. Our 2008 earnings estimates are unchanged.

• We believe that Friday, November 9 was the bottom for Canadian banks at 11.9x trailing earnings. Reiterate our overweight recommendation on the banks with 1-Sector Outperform ratings on RY and TD.

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Financial Post, Sean Silcoff, 14 November 2007

At charm school for Canadian bankers, one of the first lessons is that if you have something bad to say, it's best to have something nice to say as well.

The Big Five are notorious for coupling good news with bad when they can, despite tighter disclosure rules in recent years that were supposed to stop stage-managed earnings reports.

It's easy to be cynical about the latest bad-news/but-waitthere's-good-news! story from the banks.

On Friday, Canadian Imperial Bank of Commerce reported a $463-million writedown, pre-tax related to the U.S. subprime mortgage crisis.

But wait! CIBC also booked a $456-million gain from swapping its shares in Visa Canada for shares in Visa Inc. as the credit card giant prepares to go public.

Different day, different banks, same story.

Royal Bank of Canada yesterday said it too would book a gain, of $270-million after tax, from its Visa shares.

Oh, and, it will also write down $240-million, mostly U.S. subprime-related.

Then, Bank of Nova Scotia said it would book a $200-million pre-tax Visa gain and write down the value of its subprime-related paper by $190-million. Hmm. Coincidence?

To be fair, we knew the banks were going to book Visa-related gains. And U.S. subprime writedowns by banks aren't exactly a shocker these days.

But two things smell: the coincidental timing of the release of information on two unrelated events -- the restructuring of stakes in Visa and losses from poor risk management -- and coincidentally offsetting values of gains and losses. Three times out of three.

The banks received their Visa shares on Oct. 3, but it wasn't until early last week that an independent evaluator provided them each with the estimated value.

The banks then asked their auditors to check the valuations, disclosing the values when they heard back.

But are we to believe that on the same day, each of the banks also happened to learn the value of their subprime losses in the fourth quarter (ended Oct. 31), and that they all closely matched up?

A spokeswoman for Royal said the bank followed normal disclosure procedures "as they relate to events that may be considered material."

But she added that the bank, upon reviewing the results, decided that the two losses and one gain, though independent of one another, should be rolled into one release.

"Providing disclosure on each development in isolation would not have been responsible," she said.

Releasing material information one piece at a time is irresponsible?

That beggars belief. Here's a more plausible explanation: the banks were not going to get credit from investors for one-time Visa gains.

But they could use them to tidy up the balance sheet by matching them against expected losses.

That way, the size of their all-important capital bases would be unaffected. Investors would have nothing to worry about.

There is nothing wrong with this, but it smacks of cynicism on the part of banks.

It also suggests the banks face further writedowns. Why? Those gains they've booked on Visa presumably assume an IPO price.

Since Mastercard's IPO in May, 2006, its shares have risen almost five-fold.

If Visa follows suit, Canadian banks holding its shares could have a bigger windfall on their hands -- so much the greater to offset subprime writedowns yet to come, leaving their balance sheets unscathed. How polite, investors may agree.

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Financial Post, Grant Surridge, 14 November 2007

The ongoing subprime mortgage disaster in the United States clipped two of Canada's big banks yesterday, although market and analyst reaction indicated the writedowns were largely expected.

Royal Bank of Canada said it would take a $360-million charge (about $160-million after tax) to reflect lower valuations on its stable of collateralized debt obligations and residential mortgage-backed securities. RBC also said it would book gains related to its stake in Visa Inc., with its bottom line "only modestly affected" as a result. Investors responded by pushing up RBC shares more than 3% at the close on the Toronto Stock Exchange.

"It basically confirms there has been valuation loss in these portfolios, which I think everybody knew," Blackmont Capital analyst Brad Smith said yesterday. "These are very small amounts for all the banks."

Later in the afternoon, Bank of Nova Scotia said it would take a $190-million ($135-million after-tax) hit on assets tied up in the non-bank assetbacked commercial paper market. Scotia also cushioned the blow with a $200-million pretax gain related to Visa.

The two join CIBC, which last Friday simultaneously announced a pre-tax $463-million subprime writedown in the fourth quarter and a $456-million gain related to Visa.

Mr. Smith said he was surprised to learn Scotia had exposure to ABCP, but the writedown was a small event.

Observers said yesterday that Canadian banks are using expected gains from Visa's upcoming IPO, which could raise US$10-billion, to tidy up their balance sheets.

While damage to Canadian banks has been relatively limited, the U.S. subprime mortgage disease has infected credit markets the world over.

South of the border, Wall Street banks have announced billions in writedowns and turfed senior executives in a mad scramble to clean up balance sheets. In Europe, financial institutions in the U.K., Germany and Switzerland are expected to announce writedowns on a similar scale.

Dundee Securities analyst John Aiken estimated yesterday's writedown at RBC would cover off a third of the bank's total subprime exposure of $1.2-billion.

RBC also said on Tuesday it would take a $120-million ($80-million after-tax) charge related to increased liabilities in its credit card customer loyalty program, alongside a $325-million gain related to its stake in Visa Inc., following that company's global restructuring.

"Royal Bank is taking advantage of the Visa gain in order to shore up some areas on its balance sheet that may have some cracks," wrote Mr. Aiken in a note.

Analysts now see National Bank and Bank of Montreal, neither of which will book Visa-related gains, as the two banks to watch in the subprime writedown game.

While investors appear satisfied that CIBC's and RBC's subprime exposure is not worse than expected, Mr. Smith cautioned that global credit markets have a ways to go before sorting themselves out, and that more writedowns are a possibility.

"It does not guarantee there won't be further losses if credit market conditions continue to deteriorate," said Mr. Smith.

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Financial Post, Jonathan Ratner, 14 November 2007

After two more Canadian banks said they would take subprime-related writedowns on Tuesday, RBC Capital Markets has reduced its rating on CIBC and lowered its price target on four of the five banks it covers.

Many global banks have produced disappointing results recently and their shares have been pummeled as a result. However, RBC thinks Canadians names will see a smaller scale impact.

Nonetheless, it cut CIBC to “sector perform” from “outperform,” while $3 was shaved off its price target now at $105 per share.

The target for Bank of Montreal shares was also cut by $3 to $66. It continues to be rated at “underperform.” Bank of Nova Scotia’s target was reduced by a dollar to $54, as was National Bank to $59.

“We remain cautious on the banks and continue to prefer lifecos in the near term,” RBC analyst Andre-Philippe Hardy said in a note to clients. “If the economy remains healthy in 2008 and the U.S. financial services system does not go into a crisis, we would expect the bank stocks to provide attractive upside, but we do not expect the share appreciation to occur in the near term given the capital markets and credit overhang in U.S. financial markets.”

The Big Six banks, which also includes Royal Bank and Toronto-Dominion – RBC’s favourite name in the group – will report fourth quarter results between Nov. 27 and Dec. 6.

Mr. Hardy anticipates that TD’s earnings per share will grow at the highest rate in the group due to its lower exposure to wholesale markets and industry-leading retail growth. The analyst also thinks TD, along with Scotiabank, are less exposed to possible markdowns in their capital markets business.

But its not over when fiscal 2007 ends. Greater risk to investor sentiment will come when the banks report results for the first half of 2008, said Mr. Hardy. At that point, he expects both the broader U.S. outlook and sustainability of recent growth in capital markets will be clearer..

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Dow Jones Newswires, Monica Gutschi, 13 November 2007

Three of Canada's biggest banks are using expected gains from the VISA Inc. restructuring to offset the pain from their exposure to the eroding U.S. subprime mortgage market.

Royal Bank of Canada Tuesday joined Canadian Imperial Bank of Commerce in announcing it would take a writedown in the fourth quarter related to its holding in collaterized debt obligations and residential-mortgage backed securities linked to subprime mortgages.

Also on Tuesday, Bank of Nova Scotia said it would take a charge on its holdings in non-bank asset-backed commercial paper. Canada's ABCP market was launched into turmoil this summer on concerns about possible contagion from the U.S. subprime market.

All three, however, have been able to offset the bottom-line impact with gains expected from VISA's planned initial public offering.

"Certainly the timing worked out pretty well," said Craig Fehr, Canadian bank analyst at Edward Jones.

While the charges and gains aren't core to the banks' earnings, he said they do "speak a bit to the risk of the capital-markets segments at all of these banks."

Nevertheless, analysts said the overall exposure remains minimal and unlikely to crimp the strong growth at Canadian banks.

"If this is the extent of the pain from the collapse of structured products in the U.S., this is good news," BMO Capital Markets said in a note following Royal Bank's announcement. And Sumit Malhotra at Merrill Lynch said the charges at Royal and Canadian Imperial show "the well-publicized problem areas in the marketplace are both relatively and absolutely small."

Royal Bank, Canada's biggest lender, said Tuesday it expects to record an after-tax gain of about C$270 million (US$286 million) in the fiscal fourth quarter, based on an independent valuation of its shares in Visa Inc.

At the same time, it expects to record a charge of about C$160 million after-tax on the reduced value of its holdings in subprime collateralized debt obligations and subprime residential mortgage-backed securities. In addition, Royal Bank expects to record an after-tax charge of about C$80 million on rising redemptions on its loyalty reward program.

Later in the day, Scotiabank said its VISA-related gain would be about C$160 million after-tax, while it would take a C$135 million charge on its non-bank ABCP and structured credit instruments.

The announcements come hard on the heels of similar news from Canadian Imperial Bank, which said last week it expects a VISA-related gain of C$381 million in the fourth quarter, largely offset by mark-to-market writedowns, net of gains on related hedges, of C$302 million on collateralized debt obligations and residential mortgage-backed securities related to the U.S. residential mortgage market.

Analysts noted that Royal Bank's writedown represents 33% of its total exposure of C$1.1 billion, which Malhotra characterized as "sizable" and indicative of the rapid deterioration of the subprime market.

Still, the charge is only 3-6% of Royal Bank's total assets, said John Aiken at Dundee Securities. While that does raise the risk of further charges if the market continues to deteriorate, he noted the bank "could sustain additional charges of over C$1.4 billion without materially impairing its future growth potential."

The charges had been widely expected after all of Canada's banks revealed in the third quarter their exposure to the U.S. subprime mortgage market. Although the exposure was seen as minimal, uncertainty over the final impact - given the huge writedowns at U.S. financial institutions - has been weighing on the banks' shares.

The removal of that uncertainty spurred a bit of a relief rally in bank shares Tuesday.

In Toronto, Royal Bank is up C$1.38 to to C$51.92 on 2.9 million shares, while Bank of Nova Scotia is up C$1.01 to C$51.42 on 1.4 million shares.

"While taking writedowns is never a positive, we believe the scale of the charges (at Royal Bank) is quite manageable," BMO said.

Toronto-Dominion Bank, which earlier quantified its expected gain from VISA's IPO, is seen as unlikely to take a charge on subprime exposure, as it doesn't participate in U.S. structured credit markets.

Bank of Montreal is a MasterCard issuer. Aiken at Dundee Securities said it and National Bank of Canada are the next most-likely banks to take writedowns. Both have large exposure to Canada's asset-backed commercial-paper market.

But Mario Mendonca at Genuity Capital Markets said the absence of an ABCP-related charge at Royal Bank - which is the country's largest liquidity provider to U.S.-based conduits - could bode well for Bank of Montreal.

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The Globe and Mail, Tara Perkins, 13 November 2007

Bank of Nova Scotia announced Tuesday that it's taking a fourth-quarter writedown of $190-million as a result of its investments in asset-backed commercial paper and structured credit instruments.

Earlier in the day, Royal Bank of Canada, this country's biggest bank, announced that it will record a $360-million pre-tax writedown in the fourth-quarter as a result of its exposure to subprime-mortgage related securities.

Analysts had not been expecting a significant writedown from Scotiabank, which said it will take a hit of $190-million, pre-tax, for the quarter ended Oct. 31. That charge results from structured credit instruments and third-party asset-backed commercial paper, the bank said. It amounts to about $135-million after tax.

The bank simultaneously announced that it will record a $200-million pre-tax gain from its stake in Visa Inc.

Royal Bank's charge, which amounts to $160-million when you factor in the tax adjustment and lower bonus payments for employees, stems from the value of subprime collateralized debt obligations (CDOs) and residential mortgage-backed securities, the two types of complex financial instruments that have caused headaches for numerous banks around the world.

When RBC reported its third-quarter results in August, chief executive Gordon Nixon said it had “minimal” exposure to U.S. subprime CDOs and RMBS. Its exposure at July 31 was about $1.1-billion, which was less than 0.2 per cent of its total assets of $604.6-billion.

A dramatic rise in defaults in the U.S. subprime mortgage sector — the sector that caters to borrowers with less-than-stellar credit histories — has caused the value of these types of securities to plunge.

RBC said Tuesday that a number of other one-time charges will occur in its fourth-quarter, which ends Oct. 31, and the net result should be that they largely offset one another.

As analysts had expected, the bank will book a $325-million pre-tax gain as a result of its shares in Visa Inc. It will also take a $120-million charge because more of its customers are cashing in their points on its credit cards.

RBC's subprime writedown, which amounts to about one-third of the bank's exposure, is slightly smaller — on a percentage basis — than the charge that Canadian Imperial Bank of Commerce has taken, Genuity Capital Markets analyst Mario Mendonca said in a note to clients.

“For the most part, we believe [Royal's] subprime charge was largely expected,” he added.

Last week, Canadian Imperial Bank of Commerce announced that it will take a $463-million pre-tax hit on its exposure to subprime-related securities. That brought CIBC's total writedowns to $753-million for the last six months as a result of these investments, an issue that prompted the bank to parcel off much of its U.S. investment banking operations, which were sold to Oppenheimer Holdings Inc. for a minimal sum.

Mr. Mendonca estimates that incentive compensation, or bonuses, will be between $100-million to $120-million lower this quarter. The bank's full-year incentive compensation is about $3-billion, suggesting it will be 3 to 4 per cent lower this year, he added.

Meanwhile, analysts are watching the remaining Canadian banks for signs of trouble. Some have estimated that National Bank of Canada could face a writedown of up to $400-million in connection with its $2-billion exposure to asset-backed commercial paper. And Bank of Montreal has hundreds of millions of dollars exposed to structured investment vehicles.

National and Bank of Montreal are the “most next likely banks to incur write-downs,” Dundee Capital Markets analyst John Aiken wrote in a note to clients Tuesday.

Meanwhile, Joe Price, chief financial officer of Bank of America Corp., said Tuesday that the bank expects to take a writedown of about $3-billion (U.S.), prior to taxes, as a result of its CDO exposure.

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The Globe and Mail, Tara Perkins & Roma Luciw, 13 November 2007

Royal Bank of Canada, this country's biggest bank, has joined the parade of financial institutions that have taken a hit as a result of their exposure to the U.S. subprime mortgage market, announcing Tuesday that it will record a $360-million pre-tax writedown in the fourth-quarter.

The bank said the charge, which amounts to $160-million when you factor in the tax adjustment and lower bonus payments for employees, stems from the value of subprime collateralized debt obligations (CDOs) and residential mortgage-backed securities, the two types of complex financial instruments that have caused headaches for numerous banks around the world.

When RBC reported its third-quarter results in August, chief executive Gordon Nixon said it had “minimal” exposure to U.S. subprime CDOs and RMBS. Its exposure at July 31 was about $1.1-billion, which was less than 0.2 per cent of its total assets of $604.6-billion.

A dramatic rise in defaults in the U.S. subprime mortgage sector — the sector that caters to borrowers with less-than-stellar credit histories — has caused the value of these types of securities to plunge.

RBC said Tuesday that a number of other one-time charges will occur in its fourth-quarter, which ends Oct. 31, and the net result should be that they largely offset one another.

As analysts had expected, the bank will book a $325-million pre-tax gain as a result of its shares in Visa Inc. It will also take a $120-million charge because more of its customers are cashing in their points on its credit cards.

Shares of RBC rose were up 1.46 per cent, or 74 cents, to $51.28 in morning trading Tuesday on the Toronto Stock Exchange.

The subprime writedown, which amounts to about one-third of the bank's exposure, is slightly smaller — on a percentage basis — than the charge that Canadian Imperial Bank of Commerce has taken, Genuity Capital Markets analyst Mario Mendonca said in a note to clients.

“For the most part, we believe [Royal's] subprime charge was largely expected,” he added.

Last week, Canadian Imperial Bank of Commerce announced that it will take a $463-million pre-tax hit on its exposure to subprime-related securities. That brought CIBC's total writedowns to $753-million for the last six months as a result of these investments, an issue that prompted the bank to parcel off much of its U.S. investment banking operations, which were sold to Oppenheimer Holdings Inc. for a minimal sum.

Mr. Mendonca estimates that incentive compensation, or bonuses, will be between $100-million to $120-million lower this quarter. The bank's full-year incentive compensation is about $3-billion, suggesting it will be 3 to 4 per cent lower this year, he added.

Meanwhile, analysts are watching the remaining Canadian banks for signs of trouble. Some have estimated that National Bank of Canada could face a writedown of up to $400-million in connection with its $2-billion exposure to asset-backed commercial paper. And Bank of Montreal has hundreds of millions of dollars exposed to structured investment vehicles.

National and Bank of Montreal are the “most next likely banks to incur write-downs,” Dundee Capital Markets analyst John Aiken wrote in a note to clients Tuesday.

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Bloomberg, Doug Alexander, 13 November 2007

Royal Bank of Canada and Bank of Nova Scotia, Canada's two biggest banks, will take combined writedowns of C$295 million ($307.3 million) in the fourth quarter for their investments in asset-backed securities.

Royal Bank will take a C$160 million writedown on U.S. mortgage-backed debt, while Bank of Nova Scotia will write down the value of its commercial paper holdings and other debt in Canada by C$135 million.

The banks' writedowns will be offset by gains from the restructuring of Visa Inc., underscoring how the Canadian lenders haven't been as hard hit as their U.S. rivals from the meltdown in the subprime mortgage market. Shares of both banks rose.

``The reason why we haven't seen major-league charges out of our Canadian banks is that the issues of the day are just underrepresented,'' said Genuity Capital Markets analyst Mario Mendonca, who rates Royal Bank a ``hold'' and doesn't own the stock. ``We don't have a lot of subprime exposure, we don't have a lot of leveraged buyout type of exposure.''

Royal Bank's costs will be offset by a C$270 million Visa gain, the Toronto-based bank said today in a statement. Scotiabank, the second-biggest bank, said separately it will have a C$160 million gain from Visa.

``The Visa equity issue is good timing,'' said Pierre Bernard, vice president of equities at Montreal-based Industrial Alliance Fund Management Inc., which manages about $13.6 billion. ``We may see announcements from other banks as they clean up the place.''

Scotiabank and Royal follow Canadian Imperial Bank of Commerce in announcing writedowns to revalue debt securities. Canadian Imperial said Nov. 9 it would take a C$302 million writedown in the quarter ended Oct. 31 for investments tied to the U.S. mortgage market. Scotiabank's writedown relates to investments in non-bank asset-backed commercial paper that hasn't traded in Canada since the market seized up in mid- August.

Royal Bank shares rose C$1.58, or 3.1 percent, to C$52.12 at 4:10 p.m. on the Toronto Stock Exchange, the biggest gain in 20 months. Scotiabank rose 68 cents, or 1.4 percent, to C$51.09.

Gordon Nixon, Royal Bank's chief executive officer, said Aug. 24 that the bank had C$1.1 billion linked to the U.S. subprime market, with most of its holdings in collateralized debt obligations and residential mortgage-backed securities. Collateralized debt obligations package mortgage bonds and other debt into new securities.

Other Canadian banks may record writedowns in the quarter for asset-backed securities, including Bank of Montreal and National Bank of Canada, said John Aiken, an analyst at Dundee Securities Corp.

Canadian banks have fared better than their U.S. and European counterparts, which have recorded billions of dollars in writedowns linked to the collapse of the subprime mortgage market. Merrill Lynch & Co., Citigroup Inc. and UBS AG accounted for about 60 percent of the $45 billion of writedowns reported by the world's biggest banks and securities firms this year.

Four of Canada's six biggest banks will benefit from their stakes in Visa when they report fourth-quarter results. Canadian Imperial will have a C$381 million gain and Toronto-Dominion Bank, Canada's third-biggest lender, will have a C$135 million gain, the companies said Nov. 9. The banks' recorded gains based on an increase in value for the credit-card company ahead of a planned initial public offering.

Royal Bank said it will also record a C$80 million cost to reflect higher redemptions at its credit-card customer loyalty program. Royal Bank reports Nov. 30, with Scotiabank reporting Dec. 6.

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Scotia Capital, 12 November 2007

Event

• CM announced that it will book a $456 million gain ($1.14 per share) from the VISA restructuring, as expected. TD will book a $163 million gain ($0.19 per share). We expect RY to follow suit by making a similar announcement.

• CM also announced that it expects to write-down $463 million or $0.90 per share on its CDOs and RMBSs.

What It Means

• We view the CDO write-down as operating and the VISA gain as onetime. However, the two items would net to a positive $0.24 per share contribution in the fourth quarter.

• The pre-announced write-down is approximately $175 million higher than our previous speculation level.